Liz Laprade on the Bond Market, the Debt Ceiling and More

Liz Laprade on the Bond Market, the Debt Ceiling and More

Senior Research Analyst Liz Laprade analyzes the recent rally in the bond market. (The U.S. Aggregate Bond Index is up about 3% this month, following a year when it was down almost 12%.) Liz sees two potential risks that could reverse this trend. First, she wonders if investors are becoming too optimistic (and that the Fed may not be finished with their rate hikes). The second potential hazard is the debate over the debt ceiling.
In the unlikely scenario that Congress is unable to find a balance between the Democrats’ wishes to raise the debt limit without provisions and the Republicans’ wishes to cut spending, the U.S. could in theory default on its debt. Despite the slim probability of this outcome, the longer it goes unresolved, the more we could see bonds selling off. If you have questions for Liz, please send them to
The bond market, the debt ceiling and more...Episode Transcript

The Bond Market and The Debt Ceiling Episode Transcript

Liz Laprade:

Bonds have staged a comeback so far this month. But there are two things looming that I think could reverse that trend. So what are they and why do they pose a risk to this rally?

Hi, I’m Liz Laprade, Senior Research Analyst with Today’s Adviser Takeaway. The US Aggregate Bond Index ended 2022 down around 12%. A lot of that decline was coming from rising interest rates and inflation. This year, however, that index is up around 3% and that seems to be fueled by lower inflation and wage growth numbers.

Investors are seeing these cooling data points as a sign that the Fed might actually get inflation under control after all, and that could mean that they either slow or stop raising interest rates. So what are the two major risks I see to this bond rally right now?

The first is that investors may be getting too optimistic. The Fed may not slow or stop raising rates as quickly as some are expecting. I think the Fed would want to see inflation declining over a longer period of time than just the last month or so before they’d stop raising rates and definitely before they would cut by the end of the year.

The second risk is the debt ceiling. The debt ceiling is the legal limit to which the US government can borrow money. We reached that limit about two weeks ago, triggering a debate that we’ve seen before between political parties on how to respond. Democrats want to simply raise the limit, but Republicans would like to see some spending cuts before they would agree to raise.

For now, provisions will keep the US debt ecosystem moving along, but eventually the government either needs to agree to raise the limit or worst-case scenario, the US government would default on its debt for the first time ever. As I’ve said, we have been here before and we’ve always avoided a default. So, while I think a default is a very low probability outcome, the longer we go without a resolution, the more likely bonds start to sell off.

So, in summary while there is definitely room for the rally to continue should the Fed actually slow or stop raising rates this year and a US debt limit agreement is reached. I think these two factors pose the biggest risks to the reverse of the trend and that is it for me today. I will talk to you all next week.

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